Tuesday, May 08, 2007

Budget 2007-08: The truth they dare not tell

So you think conditions are perfect for a pre-election spending spree? You couldn’t be more wrong. I can understand why you might think so. The government is raking in much more money than it expected, for reasons it doesn’t quite understand. As Access Economics put it delicately in this year’s pre-budget Monitor: “Something weird is happening to tax revenues”.

Just last December the government lifted its revenue forecast for the coming financial year by $2 billion. It wasn’t enough. The latest Access calculations suggest it should have lifted it by $6 billion.

In contrast to earlier years, the extra money isn’t coming from a greater than expected company tax take fuelled by ever-greater profits. In fact company tax revenues are expected to come in some $900 million under budget this financial year and $800 million under next financial year.

The money is coming from you and me. A lot more of us are in jobs and our wages are increasing faster than the Treasury predicted. Access expects income from the tax we pay to beat the official forecasts by $2 billion this financial year and by almost $5 billion next financial year...

The extra money is coming from us. So shouldn’t the government be handing it back to us, either in spending or as tax cuts?

You would think so. After all, the Reserve Bank has signaled that it is unlikely to push up interest rates in response to the budget because it sees few signs of worrying inflation.

You would be in good company. Labor’s Kevin Rudd thinks that working families deserve tax cuts and giveaways so long as they don’t push up rates. In his words yesterday: “Working families are under financial pressure. So long as Mr Costello has done his numbers right and he won’t produce inflationary impact and upward pressure on interest rates, working families then do deserve a fair go when it comes to tax cuts”.

So why on earth shouldn’t the Treasurer spray around the bounty we have given him in the most electorally appealing manner possible?

Because, little discussed in all the talk about ever-expanding employment and incomes and endless economic sunshine, the fuel we need to keep the economy expanding is running low.

Don’t take my word for it. Hear what one of the smartest members of the federal parliament has to say. Labor’s Craig Emerson is the only frontbencher from either side of politics with a PhD in economics. Given responsibility in December for the service economy, small business and independent contractors he has set to work examining the things that are likely to hold Australia back in the years to come.

His manifesto, published last month, reads more like an academic dissertation than a party-political polemic, which makes it both refreshing and more genuinely disturbing.

He says that unheralded, Australia’s productivity growth – positively booming at the end of the 1990’s – has slipped away from the start of this decade. In the 1990’s the growth rate was 2.6 per cent per annum. After that it fell to 2.1 per cent, and since 2003 it has fallen to 1 per cent.

Australia’s Treasury has been rapidly ratcheting down its projections in order to keep pace. The previous budget assumed annual productivity growth of 2 per cent to the end of the decade. In December the Treasury revised that down to 1.75 per cent, and in last month’s intergenerational report revised it down further to 1.5 per cent.

Does the productivity growth rate matter?

Well, in the words of the venerable US economist Paul Krugman, quoted by Emerson, “Productivity isn’t everything, but in the long run it is almost everything”.

As Krugman puts it: “A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker”.

Our own Productivity Commission backs this up. It says that growth in Australia’s labour productivity (GDP per hour worked) has accounted for nearly all of our growth in income per person since the mid-1960’s.

Even a small difference in our rate of productivity growth can make an enormous difference to our eventual wealth. Emerson points out that if Australia’s labour productivity growth rate over the four decades examined by the Intergenerational Report was just 0.5 per cent higher than assumed, our national income would end up 20 per cent higher.

As it is, the Intergenerational Report expects Australia’s income to almost double over that period. If our labour productivity stopped growing (and if employment stopped growing as well) it would increase not at all.

What’s really disturbing for people who follow these things is that in recent months Australia’s measured labour productivity has stopped growing. In the last three quarters of last year (coincidentally since the introduction of WorkChoices) Australia’s measured rate of labour productivity growth slowed to zero. These quarterly figures can sometimes be unreliable, and Emerson doesn’t quote them.

Other economists such as Barry Hughes of Credit Suisse Asset Management look at five-year averages of compound annual productivity. He says they too have been “dwindling on a fairly consistent basis since the start of the decade”.

There are all sorts of theories as to why that might be the case. One is that employers are hiring workers they don’t need in anticipation of a labour shortage. Another is that the new workers being taken on aren’t as good as the old ones, as Australia runs low on high-quality labour.

It may be that the recent zero rate of measured productivity growth is statistically suspect. But it certainly seems that the Prime Minister was wrong to claim, as he did in late 2005, that WorkChoices would “unleash a new burst of productivity growth”.

In Emerson’s view we had better quickly find out what will. He is not alone. The IMF, the OECD, the Business Council and the former Reserve Bank governor Ian Macfarlane have all expressed concern.

The Treasury Secretary Ken Henry told his staff in March that the only budget programs that would genuinely increase Australia’s wealth were those that boosted either population, workforce participation or productivity.

He said: “You might be thinking that that’s all pretty obvious. But one of my messages to you today is that if you understand what I have just been talking about, then you are a member of a rather small minority group.”

It is looking as if the government either doesn’t understand or doesn’t want to understand.

Dr Henry and Dr Emerson have provided those of us who want understanding with a yardstick with which to judge what the politicians serve up to us tomorrow night.